Why long-term unemployment matters

“Quantity has a quality of its own.” Whether or not Stalin ever said this about the Red Army, it is true of being out of work. Evidence is mounting that the long-term unemployed aren’t merely the short-term unemployed with the addition of a little waiting time. They are in a very different situation – and an alarming one at that.

Researchers in the US are setting the pace on this topic, because it is in America that a sharp and unique shift has occurred. Broad measures of unemployment reached high but not unprecedented levels during the recent great recession. Yet long-term unemployment (lasting more than six months) surged off the charts. It has been extremely rare for long-term unemployment to make up more than 20 per cent of US unemployment, but it was at 45 per cent during the depths of the recession. In the UK and eurozone, long-term unemployment is pervasive but that, alas, is not news.

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Undercover Economist

As long as there is a recovery, why does this matter? A clue emerges when we look at two statistical relationships that are famous to econo-nerds like me: the Phillips curve and the Beveridge curve. (They are named after two greats of the London School of Economics, Bill Phillips and William Beveridge.)

The Phillips curve shows a relationship between inflation and unemployment. The Beveridge curve shows a relationship between vacancies and unemployment. Both of these relationships have been doing strange things recently: given the number of people out of work, both inflation and vacancies are higher than we’d expect.

What that means is that we can hear the engine of US economic activity revving away and yet the economy is still moving slowly. The gears aren’t meshing properly; economic growth is not being converted into jobs as smoothly as we would hope. So what’s going on?

Here’s a thought experiment: what if the long-term unemployed didn’t exist? What if we replotted the Phillips curve and the Beveridge curve using statistics on short-term unemployment? It turns out that the old statistical relationships would work just fine. We can solve the statistical puzzle – all we need to do is assume that the long-term unemployed are irrelevant to the way the economy works.

A recent Brookings Institution research paper by Alan Krueger (a senior adviser to Barack Obama during the recession), Judd Cramer and David Cho examines this discomfiting thesis in greater depth. The researchers conclude that people who have been out of work for more than six months are indeed marginalised: employers ignore them, bidding up wages if necessary to attract workers from the ranks of the short-term unemployed.

I’ve written before about an experiment conducted by a young economist, Rand Ghayad. He mailed out nearly 5,000 carefully calibrated job applications, using a computer to tweak key parameters. He found that employers were three times more likely to call an applicant with irrelevant but recent employment experience, than someone who had relevant experience but had been out of work for more than six months. Long-term unemployment had become a trap.

In Ghayad’s experiment, the long-term unemployed were identical in every other way to other applicants. In reality, of course, it may be that people also become demotivated after a long spell of looking for work. The “benefits culture” at work? It seems not. Earlier research by Krueger and Andreas Mueller tracked job hunters over time and showed them becoming ever less active in the job market – and ever more depressed. They could not rouse themselves, even when unemployment insurance payments were about to expire. It wasn’t that the people joined the ranks of the long-term unemployed because they were demotivated to start with: the long-term unemployment came first, and the unhappiness and the lack of drive came later.

. . .

There is a silver lining to all this: it suggests that those of us worried about deep, technology-driven weaknesses in the US economy may be wrong. Instead, the US economy has a cyclical problem so serious that it left lasting scars – but they will heal eventually. One can hope, anyway. Experience in Canada and Sweden during the past two decades suggests that it is possible to chip away at long-term unemployment but it takes time.

Is there a policy cure for this challenge? The rightwing intuition is tough love, based on the theory that overgenerous unemployment support merely incentivises people to sit on the sidelines of the labour market until they become unemployable. Leftwingers retort that the long-term unemployed are the victims of circumstance and need our support.

Recent evidence gathered by two economists, Bart Hobijn and Aysegul Sahin, suggests the rightwingers have a point in the case of Sweden, whereas in the UK, Spain and Portugal the labour market has been hit not by overgenerous benefits but by a structural shift in the economy away from construction. The supply of jobs no longer matches the supply of workers.

As for the US, Krueger’s research paints a picture of the long-term unemployed as people who are not very different to the rest of us – merely unluckier.